Market Rally and the Return of Irrational Exuberance

How much longer will the irrational exuberance of the current stock market rally continue? It is hard to tell but that it will end is certain.

Let us look at some hard facts: Q1 German industrial output fell 12 per cent, the worst fall since World War II; Q1 profits for S&P 500 companies fell 36.3 per cent; 539,000 Americans lost their job last month; Q1 Japanese trade crashed 50 per cent and even Q1 Chinese trade slumped 25 per cent. This is a global economic slump.

These are not reasons to be optimistic about a quick recovery in the global economy or stock markets. This is the start of a downturn that will stretch on for years: 2012 for green shoots perhaps, not 2009, just a matter of months after the financial crisis.

Inventory cycle

Why then the talk of green shoots? Get real: what is being seen is a typical inventory cycle. Recession hits and orders are held back. Eventually orders have to be placed for restocking, but that is not a recovery. Demand is still lower and probably will stay lower for a protracted period.

You also find that after some months of recession a few individuals, and even companies, that still have cash decide to spend a little as they have over done the hair-shirt mentality. Again, that is not a recovery.

It is also true that the massive injection of money into the global economy is no doubt having some impact, but is it doing any more than slowing the rate of decline and preventing systemic failure? Governments have never managed to expand economies on demand, why should they succeed in these circumstances? It expects more than can be delivered.

Or consider the more immediate irrational exuberance over the US banking stress tests. Not only was the outcome a $75 billion hole in the balance sheet of the top 19 US banks – more than twice estimates only a week earlier.

But everybody seems to have forgotten about what this means for the thousands of other US banks and financial institutions, and what about banks in Europe, Japan and all over the world. The true size of the total hole in global bank balance sheets is clearly in the trillions of dollars.

Credit deficit

Where then is the credit going to come from to fuel a recovery? Or more significantly, is this going to be sufficient in size not just to return economies to previous output levels, but set them on a growth course again?

As Ronald Reagan once commented in another context ‘You ain’t seen nothing yet!’ as far as this recession is concerned. All the figures point to a continued downwards plunge, and if the speed of decent has slowed a little that is no reason for breaking out the champagne.

There is no sign of a bottom yet or any reason to expect a swift recovery when it is reached. This truly is a time of irrational exuberance. Do you not see it?